Buy, Lease or Contract?

Oregon wineries weigh their grape-supply choices carefully

The vineyards in the foreground are owned by Bethel Heights Vineyards; the farthest distant are leased from Premier Pacific.

HIGHLIGHTS

Demand for premium grapes in Oregon's growing industry has created a perceptible increase in vineyard leasing, some experts feel.

Many wineries desire more control over the viticultural practices required to make their high-end wines.

An accountant specializing in the wine industry often recommends against leasing, believing it does not provide sufficient long-term security.

So many variables are involved that no two leases are alike.

Less than 50 years after its birth in the 1960s, Oregon's wine country has bloomed into an internationally acclaimed producing region. Today, it is home to 15 AVAs and 360 wineries with 429 brands by Wines & Vines' latest count, and vineyards growing 72 grape varieties. The recent, film-fed frenzy for its most successful grape also has driven demand for vineyard acreage suitable for growing Pinot Noir.

While wineries continue to sprout like cover crop clover, they just aren't making any more land, and smaller producers may encounter rising prices and cutthroat competition for the finest grapes. According to Kurt Wittman, relationship manager and vice president of commercial lending at Northwest Farm Credit Services (farm-credit.com) in Salem, Ore., winemakers have begun asking, "Should I lease a vineyard to stabilize my source of grapes?"

Wines & Vines examined the practice of vineyard leasing--primarily in California--in October 2006 ("The Lease You Can Do"), and for this issue decided to look at the current situation in Oregon. Wittman pointed out that, for landowners, the profit is not in being a grower. Because of the rising costs of farming, "That's been fairly anemic, until just the last couple of years or so," he said. Rather, landowners are doing "extremely well on the appreciation side."

Although Northwest Farm Credit finances leases for vineyard and winery equipment, it does not participate in land leases. But Wittman suggested that when it comes to leasing vineyards, often "neither side understands what's reasonable or what's fair." To find out, we spoke with professionals familiar with the market about the legal aspects and the financial concerns that both lessor (the property owner) and lessee must consider.

Getting real

Mike McClain's McClain & Associates Vineyard Properties in Albany, Ore., is the Willamette Valley's oldest brokerage firm specializing exclusively in vineyard and winery properties. According to his website, oregonvineyardland.com, the Willamette Valley now has some 14,000 acres planted to vines. "Land prices in Oregon are a fraction of what you could expect to pay in the Napa Valley and other prime California wine areas, but industry growth has caused sharp increases in the cost of vineyard land, and this trend is expected to continue," the website states. Prices vary widely by location: Bare land in Polk, Benton and Lane counties generally costs half, or less, than similar land in better-established Yamhill or Washington counties. Sample prices for potential vineyard properties run from around $6,000 per acre to a high of about $35,000 per acre in the prestigious Dundee Hills (2007 figures).

Wittman said that, throughout the state, "Raw vineyard land is trading between $10,000 and $25,000 per acre, with the occasional sale outside of both extremes." Vineyard development, he said, "costs around $20,000 per acre more."

McClain concentrates on sales, but he also handles some leases, "although they are a small subset of our business," he said. He pointed out that for premium Oregon Pinot, winemakers want yields to be limited.

"If you own a vineyard, you've got to look at your options, such as selling your fruit on a per-acre basis. You don't want to be producing 3-4 tons per acre and selling it at $2,000 per ton," because winemakers will be suspicious of a yield that high. In Oregon, most wineries are demanding lower yields; grapes that go into Oregon's top-tier Pinot Noir wines, typically selling for $40-$50 per bottle, tend to come from vineyards yielding perhaps 2 tons per acre, and they may command up to $4,000 per ton.

Instead, McClain suggested that vineyard owners may prefer to lease out their land and let the winery take on the cultural costs to produce exactly the quality of crop they desire. If, for example, a winery client is willing to pay $8,000 per acre of grapes, with production limited to 2 tons per acre--$4,000 per ton--"To lease, we'll assume that the lessee will take on the cultural costs of, say $4,000 per acre, and pay the lessor the balance of $4,000."

The advantage to the lessee is that, by assuming the cultural costs, "You have control," McClain explained. "The math there for the winery is that you get your high quality Pinot for $8,000 per acre. It also assumes you have your own vineyard manager."

McClain said most of the lease transactions he's seen lately have been of existing vineyards and may include equipment like tractors and implements as well. The typical term for leasing an established vineyard may be as little as five years. "To lease land that you develop, probably you should go for a 30-year term, with consumer price index adjustments every five years or so."

Since grapevines take years to produce commercially viable crops, he said, in some cases the lessee will pay only the property taxes until the vines are ready to harvest.

Appraising the situation

Carl Stillman is a real estate appraiser certified by the state of Oregon. When he began his career in the early 1990s, wine industry properties encompassed only a fraction of his practice; for the past few years, though, they have occupied most of his time. He grew up in California's Sonoma County, earned a degree in agricultural science and management at the University of California, Davis, and worked as a lab technician studying mildew resistance in grapes at Cornell University in Ithaca, N.Y. Later he worked with Mark Furusho in Sonoma County, custom harvesting grapes in Sonoma and Napa, so he's fluent in the language of winegrowing.

"The market for developed vineyards in all of Oregon is still quite thin on a year-to-year basis, with less than five vineyards selling in a given year," he said. "Most of the vine acres in the state have been planted within the past 15 years--in 1992, there were about 6,000 acres under vine; by 2007, there were around 17,400. As a result, most of the developed vineyards that have come to the market are older, self-rooted blocks with low plant densities and varietal mixes that do not reflect Oregon's recent focus on Pinot Noir."

Stillman pointed out that "self-rooted vineyards typically do not carry the value that a modern, grafted-rootstock Pinot Noir planting would carry." Like McClain, he stressed that location is critical to value, with a small, irrigated Pinot Noir vineyard with a mix of self-rooted and grafted rootstock in the Dundee Hills AVA selling recently for about $65,000 per acre, not including a homesite and structural improvements.

"In my experience, there is very little raw land that is cash leased long-term for vineyard development," he said. "I know of only a few cases where this has occurred. More typically, developed vineyards are leased…to wineries." Stillman also suggested an alternative method of securing both grapes and more control: long-term contractual arrangements in which the landowner remains responsible for most or all of the cultural operations, but the buyer has some control and can make final decisions regarding crop load and other concerns.

When shopping for a vineyard, whether for purchase or lease, Stillman said, "One of the chief value-influencing factors on Oregon vineyards relates to rootstock. A self-rooted vineyard susceptible to Phylloxera is not likely to carry the same value as a vineyard on Phylloxera-resistant rootstock, all other things being equal."

Oregon maintains strict regulations on all surface and ground water, so the ability to irrigate tends to positively affect land value, Stillman said. "This provides management flexibility in terms of vine density and varietal choice." Properties with water rights, therefore, command premium prices.

Owned by Cal Knudsen, Knudsen Vineyard has been managed by Argyle Winery since 1987. Its 120 acres are planted to Pinot Noir and Chardonnay.PHOTO: Jason Tomczak

Lease legalities

Since vineyard leases by necessity tend to run much longer than residential or other types of leases, the experts cited above agreed that both parties should retain legal help. An attorney can negotiate on your behalf, make sure your interests are protected, and dot the i's and cross the t's on your contract.

"What happens if our relationship changes, or circumstances change?" asked Jesse Lyon, an attorney specializing in the wine industry at David Wright Tremaine LLP (dwt.com) in Portland. "Say I own the land, you lease it; we may know each other, we figure we can work it out. If I pass away, you may not have that relationship with my spouse, my manager or my heirs. Often, leases and other contracts are negotiated as a snapshot, but a long-term lease cannot be based on today's circumstances."

Lyon said that he's seen an increase in vineyard leasing in recent years, particularly for raw, to-be-developed land. He explained the benefits to both parties in the transaction. "The landowner gets the appreciation in value from the development and maturation of the vineyard, and hopefully a good reputation from the grapes produced. A lease leaves vineyard development and operation to the experts who have a direct stake in producing high quality fruit on-site."

For a winery seeking to lease a vineyard, the obvious advantage over purchasing is conservation of cash, which can then be directed toward producing and selling wine. A related advantage is that, with much of rural Oregon zoned for 40-acre parcels, a lessee may be able to secure only the portion of the site suitable for grapegrowing.

"You want only the footprint within the deer fencing," Lyon said. "We wouldn't lease clear to the property boundaries; only the part we are planting."

Lyon recommended that the attorney first provide an outline of the term sheet. "Another tip, particularly for a longer-term relationship," he added: "Don't negotiate yourself such a good deal that the other side will regret it. You risk straining that relationship, and giving them an excuse to try to break the contract.

"I often consult behind the scenes in preparing a term sheet outline or letter of intent, then get directly involved in drafting the lease, and as appropriate, negotiating with counsel on the other side," he said. "My aim is to make sure that I fairly protect my clients and advise them of the risks they are assuming, while avoiding getting in the way and over-lawyering an otherwise reasonable business deal. I'm not a litigator, and I have no desire for my client to have to fight."

Accountant Jack Irvine, a CPA who runs a 14-member firm in Portland, is not as enthusiastic about leasing as some of the previous sources. His firm was founded in 1984 and curr ently represents more than 100 wineries, about 85% of its practice. He pointed out that, at least until very recently, more than 50% of Oregon vineyards were part of winery estates. This percentage has been impacted somewhat by the entry into the state market of major vineyard investors such as California-based Vintage Wine Trust (vintagewinetrust.com) and Premier Pacific Vineyards (ppvco.com), Irvine said.

He noted that, unlike California, most of Oregon's smaller vineyards were planted with the intention of making wine. "It's a whole other world up here," he said. When the practice of leasing began in Oregon, "It started with wineries leasing and developing bare land." Full service leases, such as those provided by Premier Pacific, he surmised, are probably still few and far between.

As Wittman and others pointed out, the motivation for the winery is to exercise more control over vineyard cultural practices. "Here in Oregon, people may want the rural life, buy a 20 to 80-acre parcel, and maybe plant a vineyard, but really don't know how to farm it," especially to produce the high-quality fruit the market requires, Irvine said.

"The reason a winery will lease is to try to get control of quality, so they can farm it. Historically, at least in Oregon, growers who are not winemakers don't know how to make wine. They are more biased to obtain a higher yield, but this type of grape can't compete. No matter what you do, you'll never get 6 tons per acre in the Willamette Valley. We don't get enough heat units," he explained.

"The farming cost per ton is way up there," he said. "Wineries were really frustrated, trying to get growers to produce quality fruit. So if, as a winery, you want to lower the yield, you need to take more risk." Like Stillman, he has observed a trend toward per-acre grape contracting, replacing the older per-ton system.

He noted that lease payments normally are deducted as a business expense, as part of the cost of acquiring fruit. Still, from a winery's point of view, Irvine feels leasing is not usually the preferred option for controlling the source of grapes. "If you're a long-term player, controlling the site becomes extremely important. Over a period of, say, 20 years, if you get to know that a site is good, you'll buy and develop it, because you'll get the appreciation," he said.

"Say you're building your brand and develop a following for a $50-per-bottle brand, and five or six years down the road, when it's going great, all of a sudden the lease term is up for renegotiation," he said. What might this do to the price of your grapes, your wine, and your brand?

"If that site is a terroir site, producing vineyard-designate wines, when it comes to a choice of long-term lease or ownership, I say ownership is always better. (Otherwise) you're building the brand for the vineyard, not the winery." Once that vineyard brand is established, the winery lessee may find itself priced out of the market, or the grower may decide it's time to start producing wines of his own. "It has happened," Irvine said. "I can name several vineyard owners who have done it."

On the other hand, if the only control a winery wants is to farm the vineyard, to gain more volume for lower-priced blended wines, "You may be OK with a shorter-term lease," he said. "You don't need to have fee simple ownership for total control--it's only a piece of the blend."

As an accountant, Irvine does get involved with his clients because of the financial implications. "From a cost standpoint, can you make money long-term? It's got to be sustainable. You need good reasons to go into that lease," he stressed. Finally, though, "I've recommended against many leases. Why rent if you can buy? You want to control your costs long-term, and as land values go up, your rent will go up, too."

From the grower's standpoint, he said, "They have a disproportionately large portion of the investment. It's a real estate play. Real estate plays have slower return on investment. The winery's risk is very high, but the reward is high, too. With a grower, the risk is low, but the reward is also low. Most farmers, year-to-year, make no money. Where they make it is on appreciation. Without the final, terminal value, there's no money to be made in farming," Irvine said, quoting the old chestnut, "cash poor, land rich."

So perhaps vineyard leasing, with its potential to raise the prestige and prices of vineyard property while relieving landowners of the expense and responsibility of farming, actually pays off best for the vineyard owner.

In the end, we can't really provide a definitive answer to Wittman's initial question: "What's reasonable and what's fair in leasing vineyards?" Term lengths, rootstock, grape variety, water supply--and, of course, location, location, location--are only some of the variables for each potential transaction. As Irvine said, "It's not comparing apples to apples."